Review and Outlook

May 2018

Market review

The European high-yield market, as measured by the ICE Bank of America Merrill Lynch (BofA ML) Euro High Yield Index,¹ declined 1.37% in May. Political developments in Europe drove the market’s performance throughout the month. Following a two-month stalemate, the victorious political parties in Italy’s elections, Five Star and the League, began serious talks in May. Both fringe parties had gained popular support by expressing strong views against immigration and the perceived failure of the traditional political class. Despite having acute ideological differences, the two parties found common ground in a desire to challenge the fiscal constraints on tax cuts and spending placed on the country by the European Union (EU) terms of membership. While the parties have largely stopped publicly expressing a desire to leave the Eurozone, their animosity towards Europe roiled the markets, which have become concerned about a widening rift between Italy and the EU’s core economies of Germany and France. By the end of May, the parties agreed on what they believe is a suitable prime minister candidate: Giuseppe Conte, a little-known professor and civil lawyer. However, Italy’s president, Sergio Mattarella, rejected the proposed candidate for finance minister. Despite popular support in much of the country, Five Star and the League are largely seen having a negative influence on the financial markets. Consequently, Italian bonds saw weak performance in May, with the 10-year government bond declining by 8.2% and Italian corporate issues also recording significant losses.

In Spain, Prime Minister Mariano Rajoy came under increasing pressure to resign from his post after several members of his People's Party were convicted of a range of crimes related to illegal funding of election campaigns between 1999 and 2005. The presiding judge in the cases expressed his view that Mr. Rajoy’s denial of knowledge of these matters lacked credibility. The Spanish 10-year bond fell 1.1% in May. In the UK, key economic data reports largely missed expectations, with the Consumer Price Index (CPI) at 2.4% (versus an expected rate of. 2.5%); industrial production growing by 0.1% month-over-month (versus. 0.2% expected); and Composite Purchasing Managers Index (PMI) of manufacturing activity at 53.2 (versus an expected reading of. 53.7). European political developments and the relatively weak data in the UK led the U.S. dollar to strengthen by respective margins of 2.9% and 2.0% against the euro and sterling over the month. The Brent crude oil price rose 5% to US$76.79 per barrel in May, nearly reaching the US$80 mark late in the month.

Outlook

The political complications that we have seen in Italy and Spain have reintroduced uncertainty for the market. Nonetheless, we maintain our base case that Italy will remain an integral part of the European economy. Despite this politically driven uncertainty, market technicals have remained fairly stable. Defaults by European corporate bonds, as reported by credit rating agency Moody’s, recently have remained around 2% and are expected to decline going forward.²

¹ The ICE BofA ML Global High Yield European Issuers Constrained Index tracks the performance of euro- and British pound sterling-denominated below-investment- grade corporate debt publicly issued in the eurobond, sterling domestic or euro domestic markets. Indexes are unmanaged and are included for illustrative purposes only. You cannot invest directly in an index.

² Forecasts and estimates are offered as opinion and are not reflective of potential performance and are not guaranteed. Actual events or results may differ materially.

Important Information

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, as well as political and economic risks. These risks are enhanced in emerging-markets countries.

Derivatives are speculative and may hurt the Fund’s performance. They present the risk of disproportionately increased losses and/or reduced gains when the financial asset or measure to which the derivative is linked changes in unexpected ways.

Ref. US-110618-66643-12